Decline In Corporate Governance

Decline In Corporate Governance

As Russia’s invasion of Ukraine has ruled global headlines this week, two other issues that made my head turn were the episodes involving the National Stock Exchange of India Limitedย andย ABG Shipyard Ltd. In one instance, a ๐Ÿ๐š๐œ๐ž๐ฅ๐ž๐ฌ๐ฌ ๐ฒ๐จ๐ ๐ข ๐ก๐š๐ ๐š ๐‚๐„๐Ž ๐ฎ๐ง๐๐ž๐ซ ๐ก๐ข๐ฌ ๐œ๐จ๐ง๐ญ๐ซ๐จ๐ฅ. In another example, a firm ๐—ฐ๐—ต๐—ฒ๐—ฎ๐˜๐—ฒ๐—ฑ ๐—ฎ ๐—ฐ๐—ผ๐—ป๐˜€๐—ผ๐—ฟ๐˜๐—ถ๐˜‚๐—บ ๐—ผ๐—ณ ๐Ÿฎ๐Ÿด ๐—ฏ๐—ฎ๐—ป๐—ธ๐˜€ ๐—ผ๐—ณ ๐—ฅ๐˜€ ๐Ÿฎ๐Ÿฎ,๐Ÿด๐Ÿฐ๐Ÿฎ ๐—ฐ๐—ฟ๐—ผ๐—ฟ๐—ฒ๐˜€ ๐—ฏ๐—ฒ๐˜๐˜„๐—ฒ๐—ฒ๐—ป ๐Ÿฎ๐Ÿฌ๐Ÿญ๐Ÿฎ ๐—ฎ๐—ป๐—ฑ ๐Ÿฎ๐Ÿฌ๐Ÿญ๐Ÿณ. However, the banks failed to report this fraud till 2022.

As the standards of ๐—ฐ๐—ผ๐—ฟ๐—ฝ๐—ผ๐—ฟ๐—ฎ๐˜๐—ฒ ๐—ด๐—ผ๐˜ƒ๐—ฒ๐—ฟ๐—ป๐—ฎ๐—ป๐—ฐ๐—ฒ ๐—ฐ๐—ผ๐—ป๐˜๐—ถ๐—ป๐˜‚๐—ฒ ๐˜๐—ผ ๐—ด๐—ฒ๐˜ ๐—ฑ๐—ฒ๐—ฝ๐—น๐—ผ๐—ฟ๐—ฎ๐—ฏ๐—น๐—ฒ, as an investor/analyst, i factor this when valuing companies primarily in the emerging markets in the following ways:

1)๐—ง๐—ฟ๐—ฒ๐—ฎ๐˜ ๐—ฏ๐—ฟ๐—ถ๐—ฏ๐—ฒ ๐—ฎ๐˜€ ๐—ฎ๐—ป ๐—ผ๐—ฝ๐—ฒ๐—ฟ๐—ฎ๐˜๐—ถ๐—ป๐—ด ๐—ฒ๐˜…๐—ฝ๐—ฒ๐—ป๐˜€๐—ฒ: When i value companies, especially Chinese/Indian firms, i add an operating expense – bribes to corrupt officials. Further, I am building a model on a firm’s efficiency in bribery and treating it as a competitive advantageย for firms that are good at getting results for their bribe payments.

2)๐“๐ซ๐ž๐š๐ญ ๐‚๐จ๐ซ๐ซ๐ฎ๐ฉ๐ญ๐ข๐จ๐ง ๐š๐ฌ ๐š๐ง ๐ข๐ฆ๐ฉ๐ฅ๐ข๐œ๐ข๐ญ ๐ญ๐š๐ฑ:ย In an alternate scenario, i treat corporate Corruption as an implicit tax to do business in that country.ย PwC comes up with an opacity index that adds an operating cost to do business in a country and converts it to an effective tax. For instance, they estimated the effective tax for China as 46%.

3)๐ˆ๐ง๐œ๐ซ๐ž๐š๐ฌ๐ž ๐ญ๐ก๐ž ๐œ๐จ๐ฌ๐ญ ๐จ๐Ÿ ๐œ๐š๐ฉ๐ข๐ญ๐š๐ฅ ๐ญ๐จ ๐œ๐จ๐ฏ๐ž๐ซ ๐ ๐จ๐ฏ๐ž๐ซ๐ง๐ฆ๐ž๐ง๐ญ ๐ฉ๐š๐ซ๐ญ๐ง๐ž๐ซ๐ฌ: For a firm in the emerging markets whose biggest customer is theย #government, the firm usually gives a share of its profits to corrupt officials. Thus, I increase the WACC of such a firm by a factor, and the firm needs to generate a higher return to offset these cash outflows.

In my view, ๐ฉ๐จ๐จ๐ซ ๐œ๐จ๐ซ๐ฉ๐จ๐ซ๐š๐ญ๐ž ๐ ๐จ๐ฏ๐ž๐ซ๐ง๐š๐ง๐œ๐ž ๐ข๐ง ๐ž๐ฆ๐ž๐ซ๐ ๐ข๐ง๐  ๐ฆ๐š๐ซ๐ค๐ž๐ญ๐ฌ ๐ข๐ฌ ๐š ๐ซ๐ž๐š๐ฅ๐ข๐ญ๐ฒ and analysts/investors must factor in this issue when valuing companies. Therefore, while you may disagree with my above framework, i recommend that analysts add a cost/risk layer when valuing companies in emerging markets that incorporate poor corporate governance.



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